A New Formula for Cohort Default Rates
The federal government is implementing a new method of assessing student loan default rates that will make it tougher for higher education institutions to remain eligible to receive federal student aid funds.
Currently, the Department of Education tracks how many student loan borrowers default within the first two years of repayment to determine the official Cohort Default Rate (CDR). A provision in the Higher Education Opportunity Act (HEOA) alters the CDR formula by adding an additional year. Until there are three years of three-year rates, there will be a transition period during which institutions will receive both two-year and three-year rates, and sanctions based on a high CDR will be based on an institution's official two-year rate. Beginning in late 2014, the DOE will use the percentage of borrowers that default within the first three years of repayment to determine the CDR and will impose penalties on institutions that have official three-year CDRs above a certain level.
In December, the DOE released unofficial, trial three-year CDRs to help institutions prepare for the change that will become fully effective in September 2014. The three-year rates were higher than two-year rates across all types of institutions. For-profit colleges' three-year rates were 93 percent higher than two-year rates; public two-year colleges' three-year rates were 63 percent higher, and private four-year colleges' three-year rates were 70 percent higher. Among all borrowers, the average two-year default rate was 6.7 percent in 2007. This percentage jumps to nearly 12 percent when a three-year default rate is used.
To compensate for the anticipated increase in CDRs, lawmakers also eased the minimum CDR requirements institutions must meet to remain eligible to participate in the federal loan and Federal Pell Grant programs. The HEOA increased the CDR threshold schools must remain below for its three most recent CDRs to remain eligible from 25 to 30 percent. This new threshold becomes effective when the new formula is fully implemented.
The law also makes it easier for institutions with a relatively low percentage of borrowers to appeal the potential loss of eligibility by increasing the participation rate index threshold from .0375 to .0625. A school's participation rate index is calculated based on the number of students who obtain loans compared to the number of regular students at the school. In other words, if a low percentage of a school's students take out loans and the school's participation rate index is equal to or less than the threshold, that school does not lose its eligibility.
Despite the increase caused by using three years, only a small percentage of colleges would face penalties for high CDRs if the new three-year CDR was implemented this year. Among the more than 5,000 institutions that participate in federal student aid programs, only 221 had three-year CDRs greater than 30 percent for the 2007 fiscal year. While this is a small percentage of schools, it is an increase compared to the current system. In the 2007 fiscal year, only 36 institutions faced penalties for having two-year CDRs greater than 25 percent.
Beginning Oct. 1, 2011, schools with CDRs below 15 percent (currently 10 percent) for the three most recent fiscal years will be allowed to disburse PLUS and Stafford Loans in a single disbursement for short loan periods—that is, a loan period that is not more than one semester, trimester, quarter, or four-month period.
The HEOA also requires the Department to report life cohort default rates in addition to the new three-year CDR. The new CDRs and the life cohort default rates must be broken down for each category of institution: four-year public, four-year private nonprofit, two-year public, two-year private nonprofit, four-year proprietary, two-year proprietary, and less than two-year proprietary. All schools—no matter how high or low the CDR—will have their CDRs listed on the Department's College Navigator website to help students and parents weigh college options.
Beginning with three-year CDRs published in 2012, the first time an institution's CDR equals or exceeds 30 percent, the school will be required to establish a default prevention task force to:
- Identify factors causing the high CDR at the school;
- Establish measurable objectives to lower the CDR; and
- Specify actions that the school can take to improve student loan repayment.
These plans are then submitted to the DOE for review. The Secretary is required to offer technical assistance to the institution to improve the CDR.
Schools with CDRs that equal or exceed the minimum CDR threshold for two consecutive years must review, revise, and resubmit their amended plan to the Department. The Secretary can amend the plan and require the school to take specific actions that will lead to measurable results to lower the CDR.
Federal law provides regulatory relief from any punishment from the Secretary if an institution can prove to the Department that it meets "exceptional mitigating circumstances," such as: having a disproportionate number of Pell-eligible or low-income students, having high numbers of students transfer from the school to a higher-level educational program, or having a large number of students enter the armed forces. An institution must appeal or challenge its CDR within 45 days of receiving draft CDR data. After 45 days, the accuracy of the data can not be contested.
The switch to a three-year CDR will not occur in a vacuum, and several other factors should help institutions minimize their CDR and avoid subsequent sanctions.
A new income-based repayment program became available on July 1, 2009 and will help many low-income borrowers avoid default by basing their monthly loan payments on what they can afford to pay. In addition, many colleges and student loan providers will likely adjust their default prevention programs to ensure that borrowers don't default.
As the economy improves, more student loan borrowers will be able to meet their student loan obligations. Also, the interest rates on certain student loans will continue to fall over the next several years, reducing the loan burden on borrowers and driving down default rates.
The combination of these factors should help to mitigate some of the impact of switching to a three-year CDR.
Ever since CDRs were introduced in the late 1980s to prevent unscrupulous schools from receiving federal student aid funds, critics have argued that the CDR is an ineffective method for determining the quality of an institution. These critics say other factors—like interest rates, graduation rates, and students' socioeconomic background—have a greater impact on borrowers' ability to repay their loan than the school they attend.
In addition, institutions with a large portion of low-income students are generally held to the same default standard as institutions with students from wealthier backgrounds, creating more challenges for schools with fewer resources.
It is unlikely that the federal government will stop using this metric any time soon. Dan Madzelan, the DOE's acting assistant secretary for postsecondary education, recently noted in The Chronicle of Higher Education that the CDR requirement helped weed out hundreds of colleges when it was first implemented. Despite the elimination of these institutions, enrollment continued to increase, so the CDR requirement did not hurt college access, Madzelan contended.
Given the government's increased scrutiny on loan default, it is a good time for institutions to reevaluate their student loan counseling and find additional ways to help borrowers avoid default.
Haley Chitty is director of communications for the National Association of Student Financial Aid Administrators, www.nasfaa.org.